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Why France's 75% Income Tax Rate Is Going To Be So Disastrous

France has just announced that they are indeed going to bring in a new 75% income tax rate on top earnings. This is of course going to be entirely disastrous but the interesting reason is why. For as Matt Yglesias points out, you can find people and papers that say it’ll be just fine. It won’t be, but there are people who say it will be:

The most eye-catching headline element is that President François Holllande and Prime Minister Jean-Marc Ayrault are proposing a new 75 percent top marginal income tax bracket.

That’s higher than we’ve seen in major developed countries in a long time, and some are saying it will lead the rich to flee France en masse. At the same time, this rate is very much in line with what Thomas Piketty and Emannuel Saez, two of France’s most accomplished economists, say would be best practice in contemporary circumstances.

Ah, no, that is not what Piketty and Saez actually say, it really isn’t at all what they say. An ungated version of the paper Yglesias refers to is here. The reason this isn’t what they say is this:

e2 = 0

That’s sufficiently cryptic, even gnomic, that it needs explaining. They split the possible response to tax changes into three things. The supply response (will people bother to work if you tax them too highly?), the avoidance response (how much will people fiddle their taxes?) and the bargaining response (a slightly odd thing that need not concern us here). These are e1, e2 and e3.

Then they say that if the tax avoidance response is zero because the tax system doesn’t let people fiddle their taxes then the best top tax rate is something like that sky high one which is being imposed in France. Which it might well be in terms of how much cash you can squeeze out of the rich people. However, the important question is does the French tax system offer zero such opportunities for tax avoidance?

There are a number of reasons why it does not offer zero such opportunities: investment income and capital gains are taxed differently than income for example and this violates the paper’s own requirements for avoidance to not be possible. But there’s a much larger problem with their numbers.

The paper estimates the tax avoidance possibilities by looking at the US experience:

Second, examination of the US case suggests that the tax avoidance response cannot account for a signi cant fraction of the long-run surge in top incomes because top income shares based on a broad de nition of income (that includes realized capital gains and hence a signi cant part of avoidance channels) has increased virtually as much as top income shares based on a narrower de nition of income subject to the progressive tax schedule.4 That is, the elasticity e2 appears to be small (say, e2 < 0:1).

That’s our e2 again there. The problem is that the US case is unique, not representative. For the US tax system is based upon citizenship while everyone else bases it upon residence. If you have a US passport then you are subject to US taxation (you might not have to pay any because of a low income, but you’re still subject to those tax laws). It doesn’t matter where you live in the world you still cough up to Uncle Sam. The only way out of this, the only way to “avoid” such US taxation is to give up your US citizenship. At which point the Feds will charge you all of the tax you would ever have paid anyway. So avoiding US taxation by leaving the country isn’t really an option: there is no “exit” possibility as the economists like to say. This will clearly and obviously lower that e2 value, the amount of avoidance that anyone can do in the face of higher tax rates.

However, the French tax system is, indeed all of the EU tax systems individually are, based upon residence. If today you live in Lille then you pay French tax. If tomorrow you move to London then you are subject to UK tax laws, not those of France. You do not have to change citizenship, do not require a permit or permission to do this, you just buy a train ticket and 90 minutes or so later there you are. Free of the French tax system. The value of e2 is going to be rather different in such circumstances. When there is an easy and simple exit from the entire system available at the cost of perhaps 90 euros.

The European system goes further too. You cannot prevent someone from making this move. You may not charge them an exit tax, you may not insist that they liquidate and cough up before they go, crystallise capital gains or any of the other things that the US system demands. It is one of the most basic parts of the European Union: the free movement of labour.

We get very much the same answer from the Diamond and Saez paper on this very similar point. What is that optimal top tax rate? It is very high, up there with the new French rate, if there are no allowances, no possibilities for simple avoidance or exit from the system. Where there are such possibilities then the rate falls to around 50-55%. And that includes all of the taxes on employment, including employer paid social security charges.

Which leads us to two conclusions, one immediate and one with a rather wry flavour to it.

The immediate conclusion is that this French tax rate of 75% just isn’t going to lead to any burst of extra income into the French Treasury coffers. We have, after all, just had the experience of the UK rise from 40% to 50% which didn’t pull in any more. The reason being that people can simply leave the country if they think they’re being taxed too much. And the reason that the two papers that people are pointing to say different is that they don’t. They say instead that as long as people cannot just skip the jurisdiction then very high rates will bring in more cash. But if they can….

Which brings us to the wry point. Given this possibility of simple exit from any and all of the European tax systems (and such exit does not require that one stays in the EU either) the theoretical peak of the Laffer Curve is lower in Europe than it is in the US. Where such exit is very much more difficult. Which is rather odd really, given that tax rates and the tax burden are rather higher in the EU than they are in the US. It’s almost as if each place has the tax system suitable for the other.

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During the period 1950-63, the tax rate in the United States for the highest bracket was 90% or over. http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=213 That was a period of general prosperity.

To even suggest that you can tax a country into prosperity is to make one of the silliest arguments ever – even precious few leftist socialist pigs in the Democrat party would go that far – though they try!

Laoqiao fails to grasp the alternate causality of the boom – the post war years when almost anything made sold – and you forget the recessions toward the last period of the 50′s.

Furthermore, that period in time was also influenced by a huge increase in labor union extortion of higher wages which artificially inflated incomes over what they should have been – which later caused inflation in the period after your “selected” period.

Prosperity during that period happened IN SPITE of the higher taxes and likely would have grown even faster with a lower tax rate – and the Kennedy tax cuts were an outcome of the failure of the top rates and the recession going into the 60′s.

John F Kennedy cut them, and he cut them to increase revenue and stimulate growth in the economy. Just about all economists say that when taxes are to high, the economy suffers and thus revenue suffers.

So why didn’t Obama’s tax cuts help? Because he didn’t really cut taxes, he just kept the current tax rate in effect. Now if you see those tax cuts expire, then the economy will suffer and so will revenue. Even if it is just for the upper income it expires, it will have some detrimental effect, not as much as all of them expiring, but some.

The real story here should be what the French tax is for middle income earners. When you factor in payroll taxes and VAT you get to about 40%. Compare this to the US where the current rate is about 9%. Americans love to talk about the wonderful services that you get in Western Europe but are clueless about how much it costs the middle class.

There will most undoubtedly be a revolution in this country were we to be taxed at anything close to these rates! It is the same reason why this country was founded. Stop the moronic spending and the country will thrive!

A big joke! 75% what in F..>> the French leftist are smoking ? Why any one in world would have an inttiative to open a busines or create jobs so they can get charged 75%. It will lead to higher un employment and yeah dont hold your breath that people will stick around so they can get raped yes raped out of 75% of their income. and i assure you is not going to stop the riots of freloaders .

Firstly a french citizin will still be regarded taxable to the french laws if his family lives in France. So his wife and children will have to imigrate and start living in a different country, different language, different culture. A huge step.

Secondly: if the world income is generated in France, France is still entitled to tax most of it while the “foreign” taxed person will lose to right to apply certain favourable deductions for the income tax.